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HomeMy WebLinkAbout12 - Insurance Reserve Fund Status UpdateAgenda Item No, 12 CITY OF NEWPORT BEACH ADMINISTRATIVE SERVICES DEPARTMENT Resource Management -Human Resources -Risk Management -Fiscal Services- M.I.S. • Revenue -Accounting October 26, 1998 TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL From: Dick Kurth, Administrative Services Director (acting) RE: INSURANCE RESERVE FUND STATUS UPDATE RECOMMENDATION Direct staff to transfer $1.6 million into the Insurance reserve Fund as described herein and increase Insurance Reserve Fund premiums by $750,000. EXECUTIVE SUMMARY The balance of funding set aside for the City's insurance reserve program has become unacceptably low. An immediate transfer of $1.6 million into the Fund used to administer this program is recommended. A synopsis of the situation and recommended action are provided below, and a detailed report prepared by Dan Matusiewicz, Accounting Manager is attached. BACKGROUND The City's Insurance Reserve Fund was established in 1992. It is used pay the City's expenses related to Workers' Compensation, Liability, and Compensated Absences. In accordance with the City Council Reserve Policy, it is also used to accumulate funds for future expenses in those areas. Revenue is provided to this fund by charging "premiums" to each of the departments as part of their annual operating budgets, and sometimes, by direct infusions of cash from the General, Water, and Wastewater Funds. Despite regular increases in premiums paid by departments, as well as a few direct transfers in the past, the balance in this fund has not increased adequately. This is primarily due to extraordinary losses incurred in both workers' compensation and general liability categories. It is also due to liabilities that had accumulated for many years without sufficient contributions prior to the inception of the fiord. In addition, a recently completed draft of an actuarial study projected a somewhat greater long -term liability in these areas than had previously been estimated. At this time, the fund has a negative balance and it is operating with cash borrowed from the General Fund. While this is a routine and acceptable fund accounting practice for short periods, the magnitude of the cash deficiency and the immediate prognosis regarding cash flow to and Insurance Reserve Fund Status Update October 26, 1998 Page 2 from the fund indicate that a short -term recovery is not going to happen without extra revenue. If the City declined to take any corrective action at this point, a qualified opinion from the auditors is likely. It is also likely that future Bond ratings, the cost of borrowing money, and the City's general financial reputation would all be adversely impacted. CONCLUSION In order to comply with the City Council's Reserve Policy, the Insurance Reserve Fund should have a "book" cash balance of $6,618,731 as of June 30, 1998. The actual balance is a negative $1.6 million, creating a total deficiency of $8,291,442. The Policy states that any such deficiency must be accompanied by a plan to fully fund it over a five -year period. As part of the fiscal 1998 closing entries, we can eliminate the current deficit cash balance of $1.6 million with an immediate cash transfer from the General, Water and Wastewater funds. We recommend that, of the $1.6 million transfer, $1,429,636 should proportionately come from the General Fund, with the remainder coming from the Water and Wastewater Funds. It should be noted that by making a large part of the transfer from General Fund, the General Fund Contingency Reserve will fall further away from its target reserve level. Before the transfer the General Fund, Contingency Reserve was only $300k short of its target balance of $6.3 million. After the transfer, the General fund will be $1.7 million short of meeting policy guidelines. This deficiency will be addressed during the 1999 -2000 fiscal year budget process. The remaining target reserve difference in the Insurance Reserve Fund of $6,618,731 would require annual fund surpluses of $1,323,747 for the next five fiscal years. In order to achieve this surplus, we also recommend increasing department contribution premiums by $750,000 during the 1999 -2000 fiscal budget process. Based on current cash flow projections, this increase will produce the balance required by the reserve policy in less than five years. Insurance Reserve Fund Status Update October 26, 1998 Page 3 CURRENT STATUS OF THE INSURANCE RESERVE FUND HISTORY The City has faced substantial losses during the past fifteen years in both General Liability and Workers' Compensation claims. For the last six years we have also experienced increasing pressure from our independent auditors to better fund the losses incurred in this fund. Periodically, we have updated the City Council with the grim status of the Insurance Reserve Fund and past corrective measures have included expanded insurance coverage, higher department charges, and safety awareness programs. During the last year, the City employed the services of an actuary to refine the valuation of the Insurance Fund's outstanding losses. In all prior years, staff had performed the valuations. In conjunction with the City's claims administrators, staff estimated the settlement value of all known outstanding claims based on specific case knowledge. Staff had also made non - actuarial estimates of incurred claims that had not been reported. Actuaries use a more scientific approach to valuing incurred but not reported (IBNR) claims. In a preliminary report, the actuary's valuation of IBNR claims is much higher than staff had estimated in years past. IBNR claims have two basic characteristics: those that have not "yet" been reported and those that have not "enough" been reported. Periodically, claims will roll in from some past occurrence that had not yet been reported. More dangerous however, are the one or two claims that, through time and case discovery, turn out to be far worse than were initially anticipated. Combining the actuary's more refined approach to valuing IBNRs and the newly incurred claims during 1998, the total outstanding workers' compensation claims increased 2% to $5.9 million and general liability claims increased 60% to $3.9 million. $0 Insurance Reserve Fund Outstanding Liability 0 Workers' Compensation 0 General Liability 1997 1998 Insurance Reserve Fund Status Update October 26, 1998 Page 4 IMMEDIATE PROBLEM The actuary's valuation uses nearly eighteen years of trend data, complex mathematical models and present value discount rates but, when it comes down to it, the actuary's valuation is simply an estimate. The only certainty is that the current funding levels are insufficient to meet the current and long -term obligations of this fund. For the fifth year in a row, this fund has expended more than it has collected from department contributions. The Insurance Reserve Fund, before "bail -out" transfers from the General Fund, closed the year in a $1.6 million deficit cash position. 1�lles, tF" Gmulatise Cash Fly= ----- .— . —.—. —_ 7.000.1100 ❑ Guh (&fae —Sp ai—al Tramies) 6,000,000 BQ.t(M S al Tn. -Sw0 5,000,000 ` --- - - -J —_ 4,000,000 -- 3.000.000 2.000.000 Insurance Resen'e Fund �unuiuuutam ,.",000 j11111111 -� -�11 f 1 N t�l V N (p h fq N r1 V N tO n m O� Council policy F -2, revised April 27 1998, directed staff to target cash reserves in the Insurance Reserve Fund to be 50% of the outstanding General and Workers' Compensation liability as well as 25% of the outstanding Compensated Absences liability. At the close of fiscal year 1998, outstanding liabilities in these categories and target reserve levels are as follows: Outstanding Target Target Liability Reserve % Reserve Workers' Compensation 5,901,077 50% 2.950,539 General Liability 3,851,196 50% 1,925,598 Compensated Absences 6,970,377 25% 1,742594 Long -term Liabilities 16,722.650 6,618,731 Cash intended to Fund liabilities (1,672,711) (1,672,711) Deviation From Fully Funded Liabilities 18,395,361 Deviation From Target Reserve 8,291,442 Insurance Reserve Fund Status Update October 26,1998 Page 5 The obvious poor financial condition of this fund can lead to several adverse effects including the following: • Downgraded bond and credit ratings which may increase financing costs for the City • A qualified opinion or reportable conditions letter from the City's independent auditors which may impair the City's financial credibility CORRECTIVE ACTION PLAN AND RECOMMENDATION To mitigate this problem and meet targeted reserve levels within five years, the following corrective actions are recommended: • Increased insurance coverage where economically feasible. • A 1997 -99 fiscal closing entry of $1.6 million dollars from the General Fund, Water and Wastewater reserves to cover the deficit cash position in the Insurance Reserve Fund. • Increased department charges by an additional $750,000 per year. • Increased department awareness of factors contributing to the General Liability and Workers' Compensation losses.